Trust Accounting Misconceptions

Trust Accounting
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Several misconceptions can lead to errors, and violations, in your trust account. Whether you are in a large law firm or a sole practitioner, you are not exempt from these errors. Unresolved errors can result in disciplinary action by the N.C. State Bar, while more serious violations can lead to disbarment.

As humans, we make mistakes. But in trust accounting, Rule 1.15-3(i) requires all errors be resolved timely. The past ten years, I have focused my accounting business on trust accounting and compliance. During this time, I have discovered some common misconceptions that result in violations.

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BANKING ERRORS (YES! BANKS MAKE ERRORS TOO.)

Bank errors can occur in different forms such as checks clearing for the wrong amount, checks clearing your bank twice, or checks clearing the wrong bank account. My company reconciles nearly 100 trust accounts every month, finding at least one bank error each month. Banking errors are simply out of your control. However, it is your fiduciary responsibility to identify these errors by performing bank reconciliations monthly. See Rule 1.15-3(d)(2).

Wrong Amounts: If a check clears the bank for an amount different than originally written, it must be corrected. Whether it is a penny off, or ten thousand dollars off, it must be corrected. In trust accounting, every penny matters, and belongs to a specific person. Each person must receive the exact amount they are due; not a penny more or less.

Checks Clearing Twice: Banking technology is convenient. With the click of a button on our smartphone, we can deposit a check within minutes of receipt. Along with the convenience of mobile deposits, however, comes risk for potential errors.

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For example, while performing monthly bank reconciliations for my clients, I discovered a particular mobile check deposit. Six months later that same check cleared the bank for a second time resulting in an over-disbursement on the client ledger. The bank has procedures in place to prevent this, but their procedures failed. Monthly reconciliations identified the bank error resulting in the bank correcting the mistakes.

Checks Clearing the Wrong Bank Account: I know it is hard to believe that the bank could possibly clear checks on your account that are not your checks, but it happens. This bank error was discovered while working with a new client and had occurred several years earlier. The bank refused to correct their error stating it was outside of the time period requiring them to correct it. Consequently, the attorney was held accountable and required to personally cover the $20,000 shortage in the trust account. The initial error was completely outside of the attorney’s control. However, monthly reconciliations would have identified the error.

HUMAN ERROR

We strive for perfection, but mistakes happen. During the course of my work with a new client, it was discovered two deposits containing client trust funds were mistakenly deposited into the firm’s operating bank account. Not realizing the error, checks were disbursed from the trust account resulting in an over-disbursement of nearly $50,000. A small human error with costly consequences resulted.

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TRUST ACCOUNTING COMPARED TO TRADITIONAL ACCOUNTING

Trust accounting has unique rules that do not apply to traditional accounting. Traditional accounting is regulated by the IRS and applies to your firm’s operating bank account. Trust accounting as defined in Rule 1.15 of Rules of Professional Conduct dictates how an attorney must maintain their client trust funds.

The following are just two rules showing the requirement differences between trust accounting and traditional. For trust accounting, Rule 1.15-3(b)(1) and (2) require that you identify the client on all deposit slips, and on the face of the check, for whom funds are received and disbursed on a trust account. Though this may sound like a good standard practice for an operating bank account, the IRS does not require this in traditional accounting.

Rule 1.15-3(d) requires you to prepare three reports: a bank reconciliation report, a list of client funds held in trust, and a checkbook register. And, the balance on all three reports must agree. Traditional accounting (as applies to your operating account) only prepares the bank reconciliation report. If you stop with this step, you cannot identify if your trust account is fully funded. Only after comparing the list of “positive client balances” will you identify if an over-disbursement occurred.

As an attorney, it is critical to understand the differences between the two types of accounting to ensure your attorney trust account is maintained in compliance with Rule 1.15. Dawn Cash-Salau

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